EURO GOVT-Italy, Spain yields jump as Cyprus deal seen as precedent
* Cypriot savings levy seen as risky precedent
* Analysts see risk of fresh contagion
* Bunds rally, low-rated euro zone bond yields jump
By Marius Zaharia
LONDON, March 18 (Reuters) - Italian and Spanish bond yields jumped on Monday while German yields hit 2013 lows after an EU bailout plan for Cyprus that includes a levy on bank deposits viewed by investors as setting a dangerous precedent.
Some analysts said the Cyprus deal risked sparking a new episode of contagion in the region and some expect safe-haven Bund futures to test levels close to their all-time highs.
In a shift from previous rescue packages, euro zone leaders want Cyprus to tap savers' cash in exchange for 10 billion euros of financial aid to help the country avert a default.
The move sparked fears of a run on banks elsewhere in the euro zone and worries that similar extraordinary measures might be taken if other indebted member states need funding help.
Brussels has emphasised that the measure is a one-off for a country that accounts for just 0.2 percent of European output.
The risk of a euro zone exit - still perceived as minor - was also among the near-term concerns cited by traders. Bonds issued by Cyprus plunged in value on fears its parliament might reject the deal in a vote on Tuesday, potentially paving the way to a messy default as early as June.
"Cyprus is a small country, but the message that this sends to the market is very negative: (the same) could happen elsewhere," one trader said.
Yields on debt issued by lower-rated euro zone states rose, as well as the cost of insuring against default.
Italian 10-year yields at one point rose 11 basis points to 4.72 percent and were last at 4.67 percent. Equivalent Spanish yields rose by as much as 15 bps to 5.08 percent and were last at 5.03 percent.
Traders said flows were dominated by hedge funds, which tend to open and close positions much faster than long-term investors such as insurers or pension funds, which were still assessing the potential impact of the decision.
"The market is still waiting for information on how bad could it be," RBS rate strategist Harvinder Sian said. "You have to remember that on the week Lehman went under, Bund futures ended lower than where they started."
Bund futures were 69 ticks higher on the day at 144.08, while 10-year German yields fell as much as 8 bps to 1.37 percent, their 2013 low. Two-year yields hit their lowest since Jan. 2 at 0.001 percent.
In the week that started with Lehman Brothers' filing for bankruptcy on Sept. 15, 2008 - an event that sparked a global credit crisis - Bund futures opened at 115.01 and closed at 113.73, according to Reuters data.
UBS strategist Richard Adcock saw Bund futures rising to at least 146.15. They hit a high of 146.89 last June during the Greek elections, when fears of a euro break-up reached a peak.
Some analysts said the rise in peripheral yields was an opportunity to buy. ING rate strategist Alessandro Giansanti said the spread between Italian and German 10-year yields could widen to 370 bps in the near-term from 330 bps currently, but that would be a good level to buy Italian bonds again.
"The impact may be more or less short-lived. Cyprus is an isolated event, I don't see haircuts in deposits in bigger countries, " Giansanti said, adding that the European Central Bank's so-far untested bond-buying pledge should continue to cap peripheral yields.
Cyprus's 56-member parliament will vote on the plan on Tuesday. Approval is far from a given: no party has an absolute majority and three parties have said outright they will not back the tax.
The uncertainty was felt in the island's illiquid bonds, a Greek-style haircut on which was rejected as a bailout measure because most are issued under strict international law and are held mainly by the banks whose problems triggered the crisis.
The yield on its June 2013 issue more than doubled to almost 70 percent, while the yield on a February 2020 bond rose by two percentage points on the day to 10.4 percent.
"There are two downsides," said Gabriel Sterne, chief economist at distressed debt brokerage Exotix.
"One is that the deal doesn't get past parliament and euro zone exit risks are in the short-term still in the tail, but quite high ... The other risk is what happens if Russia doesn't extend its own loans."
Moscow is considering extending an existing 2.5 billion euro loan to Cyprus. With many Russians among the depositors affected, however, the planned levy has already elicited an angry reaction from President Vladimir Putin.